Introduction

On 7 April 2017, the Market Misconduct Tribunal (the “MMT”) handed down its decision on a market misconduct investigation involving CITIC Limited (formerly called CITIC Pacific Limited) (“CITIC”) and five of its former executive directors. The  Securities and Futures Commission (the “SFC”) alleged that a circular containing a “no material adverse change” statement (the “Circular”) published by CITIC amounted to disclosure of false or misleading information inducing transactions under section 277(1) of the Securities and Futures Ordinance (the “SFO”).

Facts

On 12 September 2008, the Circular, which concerned an unrelated transaction, contained a statement that “[s]ave as disclosed in this Circular, the directors are not aware of any material adverse change in the financial…position of the Group since 31 December 2007…” (the “Statement”).

Shortly after the Circular was issued, CITIC issued a profit warning announcement (“Profit Warning”) on 20 October 2008 and disclosed that it suffered a massive mark to market loss due to a rapid appreciation of the US Dollar from a number of leveraged foreign exchange contracts (the “Contracts”). In the Profit Warning, CITIC claimed to become aware of the exposure on 7 September 2008.

The price of CITIC shares, which were suspended from trading before the Profit Warning, fell 55% after trading resumed. The SFC alleged that (i) the Statement constituted false or misleading information about CITIC’s financial position and (ii) CITIC and its five former executive directors were aware of huge financial exposure arising from the Contracts before the Circular was issued.

Section 227(1) of SFO

Under section 277(1) of the SFO, market misconduct would be committed if the following 4 elements are satisfied:

• Publication – a person, whether in Hong Kong or elsewhere, disseminates or is concerned in the dissemination of information;
• Market Effect – the information is likely to induce dealing in securities in Hong Kong or is likely to maintain, increase, reduce or stabilise the price of securities in Hong Kong;
• False or Misleading – the information is false or misleading as to a material fact or is false or misleading through the omission of a material fact (the “False or Misleading Element”); and
• Fault – the person in question knows, or is reckless or negligent as to whether the information is false or misleading.

First Interpretation on “Material Adverse Change”

When examining the False or Misleading Element, the MMT required the SFC to prove that on an objective basis, there was in existence an actual material adverse change in CITIC’s financial position instead of a mere likelihood of material adverse change.

Whilst the concept of “material adverse change in the financial position of a company” remained undefined in the SFO and the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited, the MMT set out specific requirements as follows:

• There has to be a change in CITIC’s financial position.
• The change in CITIC’s financial position has to be of such significance that:
  • it had undermined CITIC’s financial integrity; and
  • it had done so not merely temporarily but in all the circumstances for an enduring period.

MMT’s Rulings

After 31 months’ proceedings, MMT ruled that no market misconduct was found in the publication of the Circular under section 277(1) of the SFO. In particular, the MMT concluded that SFC failed to prove the False or Misleading Element.

The MMT explained that the Statement only concerned the existing material adverse change to CITIC’s financial position. The losses suffered by CITIC under the Contracts were unrealised and dependent on the Australian Dollar/United States Dollar exchange rate remaining constant throughout the tenure of the Contracts. There was no question of an actual imminent crystallisation of capital loss, nor was there evidence of any compulsion to sell or any need to terminate the Contracts. Thus, there was only a likelihood of material adverse change, but not an existing one.

Implications

In this case, the MMT issued its first interpretative guidance on the meaning of “material adverse change”. It also distinguished the announcement of a “material adverse change” from the publication of price sensitive information. Unrealised loss (e.g. mark to market loss) shall trigger the obligation to announce price sensitive information but not an obligation to announce a “material adverse change”.

However, it is important to note that in the MMT’s 160-page report, MMT expressly stated that its mandate did not involve considering why the Profit Warning was not published earlier, and whether there was market culpability for late publication of the Profit Warning. Market participants shall pay attention to the potential liabilities pertaining to price sensitive information. The SFC’s framing of the issue in the case has prevented the MMT from considering whether CITIC had failed to disclose price sensitive information in a timely manner, which as our previous newsletters (e.g. “How Late is Too Late?”, November 2016) has illustrated, imposes a much more stringent requirement.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.